Production and Costs
Production
Short-Run Costs
Short-Run vs. Long-Run
• Technically, time does not determine the
difference between “short-run” and “longrun”
The Short Run is defined by the presence of a factor of production
that is fixed in quantity –typically, this is capital (K). In the short-run,
firms can only change the amount of non-capital inputs (e.g. Labor)
The Long Run is defined by the ability for firms to vary the
quantities of all factors of production. The time in which this takes
a firm to do so may depend upon the firm as well as the industry.
SHORT-RUN PRODUCTION
• Graphically, we can analyze short-run
production
Total Product (TP) (Q): describes how output varies in
the SR as more of any variable input is used with the fixed
input, under current technology
Marginal Product (MP): the increase in output from one more unit
of an input when the quantity of all other inputs are unchanged
Average Product (AP): the total output produced divided
by the number of units of the input used
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Marginal/Average Product
• Formulas for MP and AP
• Since Kapital is fixed in quantity, we are
concerned with Marginal and Average products of
labor
MPL: ∆TP/ ∆L
APL: TP/L
What do the TP, MPL and APL curves look like?
What is the relationship between MPL and APL?
Law of Diminishing Marginal
Produce
• As a firm uses more a variable input, with a
given quantity of fixed inputs, the MP of a
variable input eventually diminishes.
Short Run Costs
• Short-run costs can be separated according
to the nature of the input:
Fixed Costs (Total Fixed Costs) (TFC): total cost to all the fixed
inputs (Overhead costs) - must be incurred in the short-run even
if don't produce anything
Total Variable Cost (TVC): total cost to the variable inputs
Total Cost (TC): sum of all the costs of all inputs in the
production process
SO, TC=TFC+TVC
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Marginal Costs
• However, when firms are choosing to
maximize profit, they are more concerned
with Marginal Costs – the cost of producing
1 more unit of output.
MC = ∆TC/∆
∆Q
What do we know about the relationship between MC and MP?
Average Costs
• Firms are also concerned with Average
Costs. In the short-run, there are 3 average
costs:
Average Fixed Costs:
AFC= TFC/Q
Average Variable Costs:
AVC=TVC/Q
Average Costs:
AC=TC/Q
Thus, AC=AVC + AFC
What do these curves look like?
Why are these curves important?
GRAPHICAL ANALYSIS OF SR COST
Graph 1: TC, TVC, TFC
1) Why is TVC upward sloping ?
2) Why does TC slope upward ?
Graph 2: MC, ATC, AFC, AVC
1) Why is AFC downward sloping ?
2) Why is AVC "U-shaped" ?
3) Why is ATC "U-shaped" ?
4) Why does MC curve slope upward ?
5 ) Where does the MC curve intersect AVC ? ATC ?
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